Spain drifts away

FT Alphaville

“…even under a stressed scenario [budget overshoot, higher than expected bank recapitalization costs and the potential direct costs to Spain if other fiscally challenged euro area countries restructure their debt] Spain’s debt levels (86.7 per cent of GDP) are considerably lower than Greece (156 per cent), Ireland (120 per cent) and Portugal (heading for 100 per cent).That reflects the fact that Spain went into the great recession with lower levels of government debt than other countries (36 per cent at the end of 2007) and, says Jenkins, that the Spanish cajas are not that big relative to size of the overall economy.” – Evolution Securities

It’s Spain of course, which has decoupled from other members of the periphery over the past three months with its bond yields not only tightening against bunds but also falling outright (from a high of 5.45 per cent to just over 5 per cent today.The question, of course, is whether this can be justified.Enter Gary Jenkins of Evolution Securities who has taken a closer look at whether this decoupling can be explained underlying factors.

We look at Spain’s projected fiscal path and then introduce some ‘stressed’ scenario events such a budget overshoot, higher than expected bank recapitalization costs and the potential direct costs to Spain if other fiscally challenged euro area countries restructure their debt. We then see how this changes Spain’s fiscal position and if the deficit/debt levels still remain ‘sustainable’ which would largely justify the decoupling from other peripherals that has taken place lately.

That’s the methodology and now the results.As you can see even under a stressed scenario Spain’s debt levels (86.7 per cent of GDP) are considerably lower than Greece (156 per cent), Ireland (120 per cent) and Portugal (heading for 100 per cent).That reflects the fact that Spain went into the great recession with lower levels of government debt than other countries (36 per cent at the end of 2007) and, says Jenkins, that the Spanish cajas are not that big relative to size of the overall economy.

It seems to us that the affordability of Spain’s debt is largely down to internal rather than external factors. Default by other peripherals will not have a significant direct effect on Spain, although there may be indirect effects, especially from a potential Portuguese default given Spain’s close ties with its Iberian neighbour. The factors that will have significant effect on the sustainability of Spain’s debt are the final cost of bailing out the savings banks, which in itself seems manageable and even in combination with a weaker economy and/or fiscal slippage would probably leave the debt at sustainable levels. Having successfully moved away from the other peripherals it is important that the fiscal discipline and economic growth expectations are met to ensure that Spain can avoid any contagion impact, if as we expect, we witness multisovereign restructuring in 2013 and beyond.

Ah, the cajas and all the real estate exposure. Here’s what Jenkins has to say about that:

In the name of prudence we will however use Moody’s worst case scenario where it sees a need for capital injections of up to €120bn, or nearly 8% of Spanish GDP when looking at the possible cost to Spain. This number highlights the difference between Ireland and Spain. Both countries have been affected by real estate and construction bubbles that brought at least parts of the banking sector down with them when they burst in 2007/2008. The cost of Ireland’s bank bailout has reached about 45% of GDP including the €24bn further recapitalisation needs announced last week (although at least in theory some of this may be raised from the private sector or subordinated debt holders rather than from government funds), Spanish cajas may be in a weak position, but relative to the size of the overall economy their losses and potential losses remain manageable.